The New Face of Grubb & Ellis

Scott Peters

Currently reading: “The Age of Turbulence: Adventures in a New World” by Alan Greenspan

When Grubb & Ellis Co. launched a strategic review with investment bankers in the fall of 2006, most Wall Street observers figured the company was in play, likely to be gobbled up by a big blue-chip brokerage rival like Staubach or Cushman & Wakefield.

Then, out of left field came a dark-horse merger partner. A small property management firm with a specialty niche in tenant-in-common 1031 exchanges, NNN Realty Advisors of Santa Ana, Calif. succeeded in striking a deal with Chicago-based Grubb & Ellis for an exchange of stock valued at more than $400 million last Dec. 7.

The combination of a brokerage giant with a 1031 specialist — the name remains Grubb & Ellis but the headquarters is now in Santa Ana — had some skeptics shaking their heads, but for new Grubb & Ellis President and CEO Scott Peters, the deal made perfect sense. Peters was NNN's CEO at the time of the merger.

In recent years NNN — the nation's No. 1 TIC sponsor within a marketplace that raised $3.6 billion in 2006 — had emerged as the biggest brokerage customer of Grubb & Ellis. The two sides already knew each other well, and their simpatico corporate cultures promised to be an amiable fit. As the smoke cleared before shareholders voted on the merger, the synergies began to look impressive.

NNN would get the public stock listing it had long coveted and a brokerage staff of some 1,800 salesmen to help find investments for 1031 clients.

Grubb & Ellis would inherit NNN's stable cash flow and strong balance sheet, giving it the financial resources to launch an expansion program overseas, and allow it to compete more evenly with multi-national industry stalwarts such as CB Richard Ellis and Jones Lang LaSalle.

“At NNN we needed a brand name that everybody would recognize. And we needed a public footprint. We got both of those when we merged with Grubb & Ellis,” says the 50-year-old Peters, who had been CEO of NNN only since November 2006.

“We're branding our product now under the Grubb name and we're cross-selling between platforms. This is a classic case where one plus one will equal something beyond two for our company,” Peters observes.

Changing of the guard

The same math apparently doesn't compute in the executive suite, however. As key leaders have peeled away from the new Grubb & Ellis, which will keep significant staff in Chicago, it's become clear that this is Peters' show to run. First, Mark Rose, the 44-year-old Grubb & Ellis CEO who had been widely lauded for shoring up the company's brokerage ranks with key hires in the past two years, was not invited to be part of the new management team and departed at the time of the merger.

In late January came the news that Anthony Thompson, 61, chairman of the new Grubb & Ellis and founder of NNN predecessor Triple Net Properties LLC in 1998, was also leaving. He was replaced by Glenn Carpenter, 64, a former NNN director who will function as a non-executive chairman of the board.

“Scott's the pitcher in this ballgame now,” says Brandon Dobell, stock analyst with William Blair & Co. in Chicago. “I never felt that Tony Thompson would be making strategic decisions going forward. And the company is too small for both Peters and Rose to try to run it together. Scott is a capable CEO, with good experience in the industry, and it's going to be on his shoulders from here on.”

The shareholders at both companies approved the merger by overwhelming margins, but since then their confidence has been shaky. When the deal was first announced in May, the stock of Grubb & Ellis (NYSE: GBE) was trading at $12 per share. When the deal closed in December, the stock had fallen to $6.43. By late January, it had fallen further to $4.25, though it rebounded by mid-February back above $6, leaving the new Grubb & Ellis with a market cap of about $260 million. The paltry total ranked the firm as a micro-cap, or below the floor many institutional investors will consider.

Peters isn't bitter about the drop in stock price. “Our whole sector is experiencing headwinds right now. CB Richard Ellis and Jones Lang LaSalle have seen their stocks fall in a comparable manner,” he says. Jones Lang LaSalle's stock recently traded at $71, down 43% from its 52-week high of $125. And CB Richard Ellis Group was at $19.50, off 55% from its high of $42.74.

At Blair, analyst Dobell theorizes that in the weeks after the merger, some NNN investors immediately sold their new Grubb shares. “They had been waiting for a liquidity event and this was it for them.”

Early roots

A native of Mansfield, Ohio and a graduate of Kent State University, Peters took an unpredictable path to his present post. An accountant, he worked at Arthur Andersen & Co. after graduation. Peters later worked in hotel development before co-founding a public REIT, Charleston, S.C.-based Golf Trust of America, in 1997. It's still in business today with a tiny market capitalization of $15 million, but Peters cashed out his interest back in 2003. He was enjoying the good life in the summer of 2004 when he met Thompson, who persuaded him to sign on with NNN.

The growth at NNN was remarkable. From a staff of a half-dozen at the start in 1998, the firm's workforce grew to 300 at the time Peters arrived and 600 at the time of the merger with Grubb & Ellis. At mid-year in 2007, NNN had 36 million sq. ft. of property under management, triple the total of four years before. At the same time, it had $4.4 billion in tenant-in-common assets under management as a TIC sponsor and an industry-leading roster of 30,000 TIC clients.

The firm had successfully raised $160 million in a private equity offering in November 2006 designed to shore up its capital reserves. The new Grubb has inherited two non-traded REITs from the old NNN. The healthcare REIT, now a year old, has raised $250 million toward its $2 billion goal, while an apartment REIT has raised $100 million toward its $1 billion goal. The 18-month-old fund is also non-traded.

NNN recently broke into the Top 10 ranking of all leading fund-raisers in non-traded real estate programs, including REITs and other investment instruments, according to estimates from Robert A. Stanger & Co., an investment banking firm that specializes in real estate.

Marginal performer

Grubb & Ellis, meanwhile, has grown in fits and spurts and struggled with profitability. Analysts reckon that NNN's operating margins in the past couple of years have run between 25% and 35%. The brokerage's margins, however, have languished in single digits at best.

Prior to the NNN merger, in its first fiscal quarter ended Sept. 30, Grubb & Ellis enjoyed an 8% rise in revenues to $126.5 million, but after special one-time write-offs, the company lost $139,000, or 1 cent per share. In fiscal 2007, Grubb lost $102.2 million, or $4 per share, though a special one-time charge of $105.3 million related to the exchange of preferred stock accounted for all the red ink. The bottom line is that in recent years Grubb & Ellis has been a marginally profitable company, when it was profitable at all.

Peters is in a hurry to fix that problem. By combining NNN's 36 million sq. ft. in property under management with Grubb's 189 million sq. ft., the newly merged property management division benefits from a boost in scale, and Peters expects to expand it further.

Grubb & Ellis currently has a corporate stable of 923 brokers, supplemented by another 900 affiliated brokers, almost all of them spread among 127 offices in 39 states plus the District of Columbia. Those numbers will grow, Peters promises, particularly as the company reaches beyond its modest network of overseas offices in London, Stockholm, Seoul and Qatar.

“Three years from now we'll have significantly more international presence,” Peters vows. “We're going to add offices in major markets overseas and bring a real international awareness to the Grubb & Ellis brand.”

Peters is watching CB Richard Ellis and Jones Lang LaSalle — those two names keep coming up in conversation — as he plots the company's future. “They are bigger than we are and have some things we don't have right now,” he says. “We want to be competing with them on much more even terms within three to five years.”

He has a ways to go. CB Richard Ellis has more than 300 offices around the world and some 29,000 employees, while Jones Lang LaSalle has more than 1.2 billion sq. ft. of real estate under management. Within the $26 billion U.S. commercial real estate services market, CBRE boasts a 13% market share and Jones Lang has 2.5%, while Grubb & Ellis has 2%, says William Marks, an analyst with JMP Securities in San Francisco.

It's still not clear how the global expansion will be accomplished. Executives suggest that the company may open some of its own offices in far-flung capitals, while buying rivals in other places.

“It doesn't take a rocket scientist to figure out the industry is consolidating,” says Jack Van Berkel, chief operating officer for Grubb & Ellis, who was hired away from CB Richard Ellis in the middle of last year to join NNN. He predicts there will be room for four or five large brokerage companies as well as boutique firms. “There may not be room for tweener, mid-sized organizations. They may become ripe for acquisition.”

So happy together

With $73 million in cash inherited from the NNN balance sheet, the new Grubb & Ellis has a current total of some $84 million in cash and no debt on its balance sheet.

That puts the company in the catbird's seat as it eyes potential merger targets. “We anticipate that the company will make at least one strategic acquisition during the next 12 to 18 months to enhance its global competitiveness,” according to Marks of JMP Securities.

While management looks overseas, it hasn't taken its eye off domestic markets that may also be ripe for expansion. Grubb & Ellis has affiliate offices in markets such as Charlotte and Las Vegas and Reno. “These are fast-growing cities and we'd like to consider starting up corporate offices in these places,” says Robert Osbrink, the company's executive vice president of transaction services.

It's no secret that many real estate services mergers — for instance, the combination of CB Richard Ellis and Trammell Crow Co. two years ago — have resulted in significant casualties, with disaffected producers fleeing rather than sharing office space with former rivals.

But the linkup of NNN and Grubb & Ellis has by all appearances gone quite smoothly, in large part because the staffs of both companies never actually competed against each other on any level. “In a merger like this you expect to lose some people,” Osbrink says. Instead, the firm is hiring new people in key markets.

What's the lure? Grubb brokers will have better access to TIC opportunities. Salespeople on the NNN side peddling 1031 exchanges will have Grubb & Ellis market research to share with clients. Grubb has tried for years to expand its construction project management and investment management businesses.

NNN's backing should allow those divisions to blossom. Ideally, there will be cross-selling between platforms, with palpable synergy in the combined firms.

Wall Street analysts are almost uniformly bullish, rating the stock a “buy.” They also expect big things from the two unlisted REITs inherited from NNN.

The best bet is that each will be spun off in public offerings within five to seven years, yielding potentially big returns for those smart enough to get in now.

As for Peters, he is realistic about problems facing the U.S. economy and commercial real estate in 2008, and says the merged company has long-term goals in mind.

“This merger is for the next 50 years,” says Peters, who resides in Scottsdale, Ariz., with his wife and four children, and divides his time between an office in Santa Ana and another in Chicago, and visits branch offices most weeks.

“The old company was awfully dependent on transaction services, which meant that every time the market slowed they'd have to scramble to cut costs and stabilize things,” says Peters. “Now the company isn't so dependent on transactions. We have more diverse sources of revenue. The merger simply accelerates our growth in the future.”